Thursday, March 26, 2009

Back to the 70s: The Threat of Inflation is Real Again

"The best way to destroy the capitalist system is to debauch the currency," said Lord Keynes. Ben Bernanke disagrees…Bernanke is printing money to buy U.S. bonds…This new gusher from the Fed, after the $700 billion TARP bailout, comes on top of a Congressional Budget Office estimate that this year's deficit will be $1.85 trillion, 13.1 percent of gross domestic product, more than twice the share of the U.S. economy of the largest previous postwar deficit…Concluding the dollar is being abandoned…markets reacted instantly. The dollar plunge was the steepest since the Plaza Agreement of 1985…The Weimar Solution, Townhall.com, Patrick Buchanan, 3/24/2009

In Weimar, in the 1920s, when the deutschmark was devalued, it got so bad that a shopping basket full of money wouldn’t buy one egg. It got so bad that when a thief attacked someone carrying all those billions of deutschmarks, the robber would let the money fly into the wind because the basket was worth more money. That’s what inflation does.

In the 1970s, beginning when Buchanan was one of Richard Nixon’s aides in the White House, and continuing for years afterwards under Carter, prices were rising at more than ten percent a year. This was partly because of Nixon's action to take the dollar off its indexing to a fixed gold price of $35 an ounce, but more because a mountain of debt from the deficit-financed Vietnam War and Great Society was monetized, i.e., bought with printed money. Both policies and three administrations effectively devalued the dollar by more than sixty percent over the decade. A $50,000 salary in 1970 was worth less than $20,000 in 1979 and taxed at the same rate. A three-year battle led by Paul Volcker and the Reagan Administration stopped inflation cold in 1983, but it took 20% prime rates and sharp restrictions on the money supply to do it. A lot of people lost their jobs. We recovered. It’s a funny thing about sane fiscal policies in response to a crisis. When the country’s government began to act as though it ought to manage the household budget, the country began to find it had room to grow.

However, from the 1973-74 bear market to 1983, inflation sapped much of the creativity and life out of the U.S. economy. Someone in their early twenties in 1973 didn’t see much promise in the future for nearly a decade. The writer speaks from personal experience. The remarkable hope and expansion of the next thirty years was not a paradigm for life anyone in America recognized in the 1970s. Typical cultural responses were movies like The GodfatherNetwork, and Serpico, deeply cynical and dark, however brilliant, or, for that matter, Star Wars, a fantasy about a world that had never been and would likely never be.

In New York, the confidence gamers played for rent-controlled, or rent-stabilized, apartments. It wasn’t just the scam that it is now, but a matter of survival. In a desperate effort to index city worker incomes to inflation, Mayor Lindsay, in a series of very foolish agreements, bankrupted the city, whose citizens effectively lost control of their own government as makeshift bureaucracies stepped in for both the Mayor and the City Council. In a cynical and desperate strategy to get some kind of income from properties bound by rent price controls on one side and skyrocketing prices on the other, landlords set tens of thousands of apartment houses on fire for insurance money. The scam became the only game in town. A master of the universe in the 1970s put his or her income in a Cayman Islands tax shelter, dodged for a rent-controlled apartment, claimed twice as many dependents as he or she had, and, in many neighborhoods, preyed on the old, the infirm, and the unwary to make a living, in short acted like a Soviet citizen trying to make it in Moscow in 1935. Every system the city depended upon, from subways to water mains, began to break down. In the blackout of 1977, the cameraderie of the blackout of the 60s was replaced by citywide looting and riots. It was an urban miniature of Atlas Shrugged. This is what inflation does.

That is also what happens when you spend far beyond your means. And, by comparison, what the Congress and White House are trying to do now dwarfs what happened in the 1970s. They are risking Weimar by flooding the market with phony money. And what followed Weimar was not a rational reconstruction of Germany but Adolf Hitler. This is a lesson they're about to learn in Britain all over again. And it's coming here fast.

Buchanan puts it best:

Inflation is theft. It make liars and cheats of governments. By eroding the value of a currency, inflation punishes savers and creditors and rewards debtors. And what nation is the biggest debtor of them all? The United States of America. Insidiously, inflation consumes the value of cash, savings, municipal bonds, corporate bonds, Treasury bonds and T-bills. Friends who lent America money, who bought our debt in good faith, are robbed…(The Weimar Solution, Buchanan…cont’d)